Personal Finance

Managing Your Money

5 Ways to Put Your Tax Refund to Work

By Danny Wilson, learning and development advisor, Pinnacle Financial PartnersFriday April 05, 2013

I know a lot of people who celebrate Christmas twice a year—once on Dec. 25, but also in the spring when they get their tax refund. Tax refunds aren’t really gifts, though, and they don’t come from Santa Claus. Thinking of them in this way often leads to ill-advised purchases and unplanned spending sprees.

Instead, consider the money you get back from the IRS as an opportunity to put it to work for you. Here are five great things you could do with it.

1. Add to your emergency fund

An emergency fund is vital to the health of your short-term and long-term finances. The unexpected happens, and expenses often pop up out of nowhere. Without an emergency fund you’ll have to borrow, reach for the credit card or pull money out of investments. Most experts recommend setting aside three to six months of living expenses. You’ll sleep better at night.

2. Pay off debt

For every dollar you use to pay off debt, in essence you are earning the equivalent of whatever the rate on that debt is. For example, say you have a credit card with a 15 percent interest rate and a $1,500 balance. Paying it off would be similar to having a $1,500 investment that was paying you 15 percent (and good luck finding that high of a return somewhere else). Having even one less bill feels great, and it gives you more flexibility each month.

3. Set aside for a future large purchase or expense

Do you know of a large purchase or expense that is coming up in the next year or so? Setting aside the money to pay for it now will keep you from having to scramble to come up with it or find financing for it. Like your emergency fund, you will want to keep it in a separate savings or money market account, because it will have a tendency to disappear if comingled with other money in your existing accounts.

4. Fund a Roth or traditional IRA

A great way to use your tax refund is to invest it in an IRA that is tax free or tax deferred. The maximum contribution for both Roth and traditional IRAs for 2013 is $5,500 (or $6,500 if you are 50 or older). Roth IRA contribution limits start to phase out if modified adjusted gross income is greater than $112,000 for singles or $178,000 for those married filing jointly.

5. Give to others

If your financial house is pretty much in order, then your tax refund may be an opportunity to help someone less fortunate. For some this might mean a family member or close friend. For others it might mean giving to a charity that helps those in need locally or around the world. A very wise man once said that it is more blessed to give than to receive. Ironically, giving to charity may also be tax deductible.

If your tax refund was substantial, you might want to adjust your W-4 form and claim fewer allowances. This would give you an immediate pay “raise” that you could use throughout the year.

The tips in this article are general guidelines, but you can contact your tax advisor for specific advice about your particular situation.